The U.S. savings rate—as a percentage of disposable personal income— fluctuated greatly over the last 5 years. In 2015, it hovered around 7%. But in April 2020 when the COVID-19 pandemic roared to life and the economy began to suffer, savings jumped to 33.7%. In December 2020, Americans resumed their spending habits, decreasing the amount they saved to 13.6%.
Personal finance experts suggest saving 20% of your income. This will enable you to pay for major expenses (vacation, home repairs, etc.) with cash instead of credit, create an emergency fund, and build a retirement fund.
Many parents and grandparents want to know how to teach their children to save. The earlier a child learns these skills, the easier it will be to save throughout their lifetimes. Roth IRAs (individual retirement accounts) are one solution. This is a savings account that increases in value by compounding interest. The longer the account is kept, the greater the interest it earns. Some young people with earned income are realizing that a Roth IRA is a gift that keeps growing, long after graduation.
Consider this: If an 18-year-old high-school senior starts a Roth IRA with just $1,000, and makes no additional contributions to the account, that investment will be worth more than $38,000 at age 72, assuming an average annual return of 7% over the long term. If the graduate contributes just $600 a year for those 54 years, the investment grows to more than $383,000.
There are some important rules to know before opening a Roth IRA:
- There is no age requirement.
- To be eligible for a Roth, anyone (including a child) must have earned income from a job; investment income, allowances, and money earned from chores do not count.
- You only can make a gift equal to (or less than) the amount of the child’s earned income, up to the $6,000 limit.
- You will be taxed on the money going into the account, but all withdrawals after age 59½ will be tax-free.
- If withdrawals are made within the first five years after opening the Roth IRA, then a ten percent penalty tax will be applied.
Compound interest is a powerful tool, making a Roth IRA at graduation a gift that steers the young adult down a sensible savings path for life. Check with the credit union for more information.
· Source: U.S. Department of Commerce, Bureau of Economic Analysis